The Elgin Golf$–$Dutton Golf Merger

Elgin Golf Inc. has been in merger talks with Dutton Golf Company for the past six months. After

several rounds of negotiations, the offer under discussion is a cash offer of $$250$ million for Dutton

Golf. Both companies have niche markets in the golf club industry, and both believe that a merger

will result in synergies due to economies of scale in manufacturing and marketing, as well as significant

savings in general and administrative expenses.

Bruce Wayne, the financial officer for Elgin, has been instrumental in the merger negotiations.

Bruce has prepared the following pro forma financial statements for Dutton Golf, assuming the

merger takes place. The financial statements include all synergistic benefits from the merger.

If Elgin Golf buys Dutton Golf, an immediate dividend of $$67\mathrm{.}5$ million would be paid from Dutton

Golf to Elgin. Stock in Elgin Golf currently sells for $$87$ per share, and the company has $18$ million

shares of stock outstanding. Dutton Golf has $8$ million shares of stock outstanding. Both companies

can borrow at an $8\%$ interest rate. Bruce believes the current cost of capital for Elgin Golf is

$11\%.$ The cost of capital for Dutton Golf is $12\mathrm{.}4\%,$ and the cost of equity is $16\mathrm{.}9\%.$ In five years, the

value of Dutton Golf is expected to be $$270$ million.

Bruce has asked you to analyze the financial aspects of the potential merger. Specifically, he has

asked you to answer the following questions:

$1.$ Suppose Dutton shareholders will agree to a merger price of $$31\mathrm{.}25$ per share. Should

Elgin proceed with the merger?

$2.$ What is the highest price per share that Elgin should be willing to pay for Dutton?

$3.$ Suppose Elgin is unwilling to pay cash for the merger but will consider a stock exchange.

What exchange rate would make the merger terms equivalent to the original merger price

of $$31\mathrm{.}25$ per share?

$4.$ What is the highest exchange ratio Elgin should be willing to pay and still undertake the

merger?

$20182019202020212022$

Sales $$360,000,000$ $ $405,000,000$ $ $450,000,000$ $ $508,500,000$ $$562,500,000$

Production costs $248,000,000284,000,000315,000,000355,500,000393,000,000$

Depreciation $36,000,00041,000,00045,000,00051,000,00056,000,000$

Other expenses $33,000,00036,000,00037,000,00038,000,00038,000,000$

EBIT $ $43,000,000$ $ $44,000,000$ $ $53,000,000$ $ $64,000,000$ $ $75,500,000$

Interest $8,500,00010,000,00011,000,00011,250,00012,500,000$

Taxable income $ $34,500,000$ $ $34,000,000$ $ $42,000,000$ $ $52,750,000$ $ $63,000,000$

Taxes $(40\%)13,800,00013,600,00016,800,00021,100,00025,200,000$

Net income $ $20,700,000$ $ $20,400,000$ $ $25,200,000$ $ $31,650,000$ $ $37,800,000$

Additions to retained

earnings

$0$ $ $15,400,000$ $ $11,700,000$ $ $11,700,000$ $ $10,800,000$

MINI CASE